What is meant by working capital management? What factors would you like to take into consideration in estimating the working capital requirement of a concern? Discuss the repercussions if a firm has inadequate working capital.

ANSWER:
Working
capital is that part of company’s capital which is used for purchasing raw
material and involve in sundry debtors. We all know that current assets are
very important for proper working of fixed assets. Suppose, if you have
invested your money to purchase machines of company and if you have not any
more money to buy raw material, then your machinery will no use for any
production without raw material. From this example, you can understand that
working capital is very useful for operating any business organization. We can
also take one more liquid item of current assets that is cash. If you have not
cash in hand, then you can not pay for different expenses of company, and at
that time, your many business works may delay for not paying certain expenses.
If we define working capital in very simple form, then we can say that working
capital is the excess of current assets over current liabilities.

Types of Working
Capital:

1. Gross working capital:

Total
or gross working capital is that working capital which is used for all the
current assets. Total value of current assets will equal to gross working
capital.

2. Net Working Capital:

Net working
capital is the excess of current assets over current liabilities.

Net Working Capital = Total Current Assets – Total Current
Liabilities

This amount shows that if we deduct total current liabilities from total
current assets, then balance amount can be used for repayment of long
term debtsat any
time.

3. Permanent Working Capital:

Permanent
working capital is that amount of capital which must be in cash or current
assets for continuing the activities of business.

4. Temporary Working Capital

Sometime,
it may possible that we have to pay fixed liabilities, at that time we need
working capital which is more than permanent working capital, then this excess
amount will be temporary working capital. In normal working of business, we
don’t need such capital.

FACTORS THAT TAKEN INTO CONSIDERATION BEFORE ESTIMATING WORKING
CAPITAL

What is the need for working
capital?

After study
the nature of production, we can estimate the need for working capital. If
company produces products at large scale and continues producing goods, then
company needs high amount of working capital.

What is optimum level of Working capital in
business?

Have you
achieved the optimum level of working capital which has invested in current
assets? Because high amount of working capital will decrease the return on investment and low
amount of working capital will increase the risk of business. So, it is very
important decision to get optimum level of working capital where both
profitability and risk will be balanced. For achieving optimum level of working
capital, finance manager should also study the factors which affects the
requirement of working capital and different elements of current assets. If he
will manage cash, debtor and inventory, then working capital will automatically
optimize.

What are main Working capital policies of
businesses?

Policies
are the guidelines which are helpful to direct business. Finance manager can
also make working capital policies.

The Repercussions if a firm has inadequate working capital

1. The firm is unable to take
advantages of new opportunities or adapt to change.

2. Trade discounts are lost. A firm
with sufficient working capital is able to finance larger stocks and can
therefore place large orders.

3. Cash discounts are lost. Some
firms will try to persuade their debtors to pay early by offering cash
discounts.

4. The advantages of being able to offer
a credit line to customers are forgone.

5. Financial reputation is lost due
to non-payment of trade creditors on time.

6. Creditors may apply to the court
for winding up if the firm fails to pay their obligations on time.